US embassy cable - 03LAGOS2422

C O N F I D E N T I A L SECTION 01 OF 04 LAGOS 002422 
 
SIPDIS 
 
 
E.O. 12958: DECL: 11/25/2013 
TAGS: EPET, ENRG, PINR, EINV, NI 
SUBJECT: NIGERIA'S TRANSITION TO A DEREGULATED DOWNSTREAM 
SECTOR 
 
REF: A. LAGOS 2330 
     B. LAGOS 2078 
     C. ABUJA 1700 
     D. ABUJA 1737 
     E. LAGOS 2090 
     F. LAGOS 2100 
     G. LAGOS 2322 
     H. LAGOS 2287 
 
 
Classified By: J GREGOIRE FOR REASONS 1.5 (B) AND (D) 
 
 
1. (C) SUMMARY. At the monthly Businessman's Lunch held at 
the American Guest Quarters pub in Lagos on November 6, 
executives of two major fuel marketing companies confirmed 
that the sector is essentially deregulated, and that there is 
no significant threat of mass action by organized labor (ref 
A).  They noted that the industry must have regular access to 
dollars to pay for their fuel imports, and suggested that 
changes are needed to the Nigerian Dutch Auction System (DAS) 
for currency exchange in order to handle the volume of 
exchange the marketers require monthly.  END SUMMARY. 
 
 
----------------------- 
THE RECENTLY OLD SYSTEM 
----------------------- 
 
 
2. (SBU) Until October 2003, Nigeria's downstream petroleum 
sector had been closely regulated and controlled by the GON 
(ref B).  Retail sellers faced both price ceilings on all 
refined products as well as profit margin caps and "bridging" 
fees collected ostensibly to help move fuel to the north from 
southern refineries and from the port of Lagos.  Nigeria's 
four refineries have never worked at full capacity, and their 
production has never met domestic demand.  Thus, even as 
Nigeria became the world's seventh largest exporter of crude 
oil, it found itself importing much, if not most, of its 
refined fuel needs through private marketers and the Nigerian 
National Petroleum Corporation (NNPC). 
 
 
3. (SBU) As world market prices for fuels increased in recent 
years, private marketers eventually stopped importing fuel 
because they could not sell it profitably given GON price 
ceilings.  By 2002, NNPC was essentially the sole importer of 
fuels to Nigeria.  (Note: Depending on the state of the 
country's refineries, imports generally account for 60 to 100 
percent of domestic fuel supply. NNPC benefited from GON 
subsidies as it imported fuel at market prices but sold it to 
private marketers wholesale and to consumers through several 
retail outlets at the artificially low price caps.  When its 
refineries worked, the Nigerian National Petroleum 
Corporation (NNPC) was also allowed to buy oil from Nigeria's 
crude production at prices far below market.  This 
two-pronged NNPC subsidy was said to cost the GON some two 
billion dollars annually.  In late June 2003, the GON raised 
the price ceiling (effectively raising the price) of gasoline 
to 40 naira per liter from 26.  A nationwide protest strike 
that resulted in scattered violence and several deaths 
effectively shut down the country for eight days.  A 
compromise was reached setting the price for gasoline at 34 
naira per liter. 
 
 
--------------------------- 
THE ARRIVAL OF DEREGULATION 
--------------------------- 
 
 
4. (SBU) This system changed dramatically when President 
Obasanjo deregulated the downstream sector by pronouncement 
on October 1, 2003 (ref C).  Although private marketers 
believed Obasanjo had promised them that all price caps would 
be lifted and prices would be market driven from that day 
forward, the NNPC maintained its selling price at the 
previously imposed ceiling.  Consumers became confused 
overnight, as private fuel stations began charging 40 naira 
per liter or more for gasoline, while NNPC stations kept 
their price at 34.  Panic buying soon escalated tension and 
black market prices, and fuel queues began snaking from 
stations once again.  When confronted by angry accusations 
from an array of fronts that he had unilaterally raised fuel 
prices for the second time in six months, Obasanjo replied 
that any increase in fuel prices was not his doing.  He 
insisted that he had merely deregulated the downstream 
sector; retailers were now setting prices. This left private 
marketers politically exposed, and gave the Nigerian Labor 
Congress (NLC) a vehicle from which to rally.  The NLC 
denounced both Obasanjo for failing to consult civil society 
before making such a significant change to government policy 
and operations, and the fuel marketers for taking advantage 
of the common man for the sake of profits. 
 
 
5. (SBU) The country was headed for another nationwide work 
stoppage when an agreement to avert the strike was reached 
late on October 8 (refs D, E). But the agreement unraveled 
almost as soon as it was reported (ref F).  The unions 
insisted that marketers agreed to keep prices at 34 naira per 
liter for at least one month while a Stakeholders Committee 
was formed and would meet to discuss and manage deregulation. 
 Marketers maintain they did not agree to continue selling at 
the previous price cap.  They say they tacitly agreed that 
prices would likely remain at 34 naira until the first 
shipment of fuel imported by marketers hit the Lagos port. 
(Marketers  maintain that the lowest viable price for 
gasoline is  currently 40 naira per liter.)  The marketers 
claim union officials misjudged how long it would take the 
first industry shipment of gasoline to arrive; while unions 
believed it would be at least four weeks, Unipetrol had 
already placed an order for two shipments relying on the 
President's pledge to deregulate, and those shipments were 
underway as the strike deal was reached.  Subsequently, just 
days after the supposed "agreement," prices again jumped 
overnight.  NLC leaders claimed they had been duped, and some 
union elements began targeting private dealers for pickets, 
protests and even violence.  In the confusion some dealers 
closed, inciting passions even further as consumers had even 
less fuel available to them and opportunists and 
black-marketers took advantage of the supply crunch. 
 
 
6. (SBU) Most marketers rolled back their prices quietly to 
avoid confrontation, but as the stalemate dragged on and the 
federal government appeared intransigent, the NLC's pressure 
and sway on the issue began to weaken and fade.  By the end 
of October, most union leaders admitted they retained too 
little momentum to call the strike back on. The Stakeholders 
Committee met but accomplished little, and Obasanjo took 
other shots at the NLC via legislation to curtail it's power 
(ref G).  Meanwhile, marketers continued to import fuel, and 
NNPC itself shifted to market prices.  By the third week of 
October, fuel queues in Lagos all but vanished, and the 
average cost of gasoline now hovers around 39 to 42 naira per 
liter.  As had been the case even when the GON imposed a 
price cap, fuel prices in regions outside of urban centers 
vary, as supply to bush regions and to the north is spotty. 
(Note: domestic disturbances also affect fuel availability. 
For example, Econoff noted on November 13 and 14 that long 
and testy fuel queues stretched throughout the southern city 
of Port Harcourt.  Earlier in the week, demonstrations and 
violent clashes sparked by the murder of a traditional ruling 
chief blocked the road between the city and the nearest fuel 
depot, causing a supply crunch by Thursday, and a run on 
re-opened stations on Friday.) 
 
 
------------------------------------ 
DEREGULATED, BUT WATCHED AND PRODDED 
------------------------------------ 
 
 
7. (C) At the Businessman's Lunch on November 6, John 
Pototsky, Managing Director of Mobil Nigeria, and Jules 
Harvey, Vice President for West Africa of Texaco 
International, said the marketers have been told by GON 
officials at the NNPC, the Department of Petroleum Resources 
(DPR) and the Petroleum Products Pricing Regulatory Authority 
(PPPRA) that while the downstream sector is operating in a 
deregulated environment, the agencies do not want to see 
widely varying prices around the country and between 
retailers.  Pototsky said the industry has been warned, 
"don't cause chaos with prices."  He said there seems to be a 
regional split forming within the ranks of decision makers 
and regulators, with northern government officials winning 
dominating policy decisions these days.  Some have called for 
price fixing and the continuation of the Petroleum 
Equilisation Fund (PEF), which is essentially a tax on sales 
to pay marketers for costs associated with transporting fuel 
from the Lagos port to the north (known as "bridging"). 
 
 
8. (C) Pototsky also noted that the GON seems focused only on 
gasoline prices; officials ignore what the retailers charge 
for diesel or kerosene, which are the fuels primarily used by 
industry and businesses.  The same can be said for organized 
labor.  From the outset of the deregulation effort, all 
attention has been on the price of gasoline.  Even the 
agreement reached on October 8 accepted that kerosene and 
diesel prices would immediately rise to market rates.  (Note: 
Because of Nigeria's inadequate power grid, almost all 
businesses use generators to supply backup or primary power, 
adding a significant cost to doing business here.  Nigeria's 
stagnant textile industry has linked deregulation to an 
effect on production by publicly claiming some 50,000 jobs 
may be lost due to the increased cost of running textile 
mills after a rise in NNPC's "black oil" price and an alleged 
diversion of industry fuel allotments.) 
 
 
9. (U) Meanwhile, the DPR has issued new guidelines and 
directives for marketers on issues including import 
licensing, quality control and safe transportation of 
products. 
 
 
----------------- 
PLENTY OF FUEL... 
----------------- 
10. (C) Mobil's Pototsky and Texaco's Harvey indicated that 
the industry is fully engaged in fuel importation.  Pototsky 
was quoted in the press as saying his company anticipated 
importing 13.4 million liters of gasoline in three shipments 
by mid-November. (Note: Pototsky and Harvey noted that most 
gasoline imported to Nigeria is unleaded -- now the most 
common gasoline available on world markets -- even though 
vehicles here are generally equipped for leaded fuel.  There 
has been discussion in recent months among African leaders 
that countries should convert to unleaded gasoline in the 
near future, but Pototsky said retailers here cannot market 
their gasoline as "unleaded" because it often becomes blended 
with NNPC fuel of varying grades when stored in tanks.) 
 
 
11. (C) In a separate conversation with Econoff, an 
ExxonMobil official stated that the downstream industry is 
now trying to import as much fuel as possible, in effect 
"flooding the market."  He said the marketers are doing so 
primarily to ensure a steady supply of fuel nationwide.  He 
said that in this time of tense transition to a market-based 
fuel sector, they do not want to give the unions or any other 
detractor the opportunity to claim that in spite of 
deregulation -- or perhaps because of it -- not only has the 
price of gasoline risen, but the country still faces 
shortages.  Thus, according to the ExxonMobil official, the 
goal of the marketers for the near term is to flood the 
market with fuel, and get it distributed nationwide.  Along 
with trying to ensure stable supply and prices, the industry 
has turned to public outreach to win consumers to the side of 
deregulation; new radio jingles paid for by the marketers 
extol the benefits of deregulation. 
 
 
---------------------------- 
...BUT HOW DO WE PAY FOR IT? 
---------------------------- 
 
 
12. (C) The marketer's new problem, according to Pototsky, is 
getting enough foreign currency to pay for the fuel 
shipments.  Businesses in Nigeria can acquire dollars twice 
weekly through Nigeria's Dutch Auction System (DAS).  Each 
Monday and Wednesday, the Central Bank of Nigeria (CBN) 
announces the amount of dollars it will be auctioning. 
Companies seeking dollars then post a bid via an authorized 
bank.  They specify what amount they seek, at what rate they 
will exchange naira for that amount, and for what purpose 
they seek the dollars.  An amount of naira equivalent to 
their bid must be available in their bank at the time the bid 
is made.  On Tuesdays and Thursdays the CBN announces the 
winning bids, and immediately deducts the equivalent naira 
from the current accounts of the banks representing the 
winning bidders.  The CBN then transfers dollars into the 
correspondent bank accounts of the winning bidders.  Any 
dollars not used must be returned to the CBN within five days 
to be exchanged for naira at the rate the dollars were 
purchased. 
 
 
13. (C) According to Pototsky, when the President deregulated 
the downstream sector in a relatively sudden manner last 
month, his administration did not anticipate the need of the 
marketers to obtain dollars to pay for fuel imports. 
Pototsky said that when NNPC pays for an imported shipment, 
it uses dollars it obtained from crude oil sales kept in 
accounts outside of the DAS.  He told Econoff that marketers 
now need approximately $120 - $150 million per month to pay 
for their fuel shipments, and are obliged to obtain dollars 
only through the DAS.  He said they found themselves outbid 
at several DAS auctions in October, and realized further that 
their bids could equal up to 35 percent of the dollars sold 
at any given auction.  On November 12 Pototsky told Econoff 
that while the CBN sold enough dollars to Mobil in the 
November 5th auction to cover its outstanding invoices, he is 
not certain how Unipetrol fared. (Unipetrol was the first 
marketer to import fuel after deregulation took effect.) 
 
 
14. (U) (Note: The CBN uses the DAS to control the exchange 
rate, so the amount of dollars it supplies at each auction 
varies, and the supply relative to the demand can vary 
widely.  For example, the CBN managed to keep the DAS 
marginal exchange rate at 135.55 naira to the dollar on both 
November 3 and November 5.  However, the amount of dollars 
sold ($103 million and 331 million respectively) accounted 
for 82 percent of the demand on November 5 (bids totaled $403 
million), and only 30 percent on November 3 (bids totaled 
$351 million).  On November 10, bidders requested $217 
million, and the CBN sold $183 million, or roughly 85 percent 
of demand, maintaining the exchange rate at 135.52 naira to 
the dollar.) 
 
 
15. (C) Pototsky told Econoff that marketers want the GON to 
create a separate allocation of dollars available for fuel 
purchases, or allow for advance funding of fuel purchases. 
Pototsky also said that he and other marketers are worried 
that under the current system, they will either not obtain 
dollars in time to pay their fuel invoices, or the large 
volume of their bids at any given auction will "decimate" the 
DAS.  The marketers' bids for dollars might create spikes in 
demand and, if successful, edge out other industries for 
access to the limited amount of foreign currency allowed by 
the CBN at each auction.  The new managing director of 
Citibank Nigeria told Econoff that another option the 
marketers may pursue is to press the GON to allow the 
companies to buy dollars as an industry block through a 
"syndicated import letter of credit," rather than 
individually through the DAS as they do now.  That option may 
become more important in the future if companies choose to 
order shipments jointly; currently, each company orders its 
own fuel shipments and sells some of it (in naira) to the 
others when a shipment arrives in port.  (As Mobil's Pototsky 
told Econoff, "We're tough competitors when it comes to 
selling product and services throughout Nigeria, but we 
shouldn't compete bitterly just to get the product here. 
That could really blow out the market.") 
 
 
-------------------------- 
THOUGHTS ON NEW NNPC CHIEF 
-------------------------- 
 
 
16. (C) At the Businessman's Luncheon, Pototsky and Harvey 
praised the new group managing director of NNPC, Funso 
Kupolokun, for his decision to attend a marketers' meeting 
the day after his appointment was announced (ref H) to 
reassure the industry of the President's resolve to 
deregulate and reform the downstream sector.  Both men agreed 
that Kupolokun has been accessible in the past and 
understands the industry well.  However, Bob Smith, MD of 
ConocoPhillips (upstream), cautioned that Kupolokun may be 
too "hands on" and not delegate enough decision-making, 
making the organization more bureaucratic and lethargic. 
Most oilmen at the table agreed that there is a risk of 
stagnation within NNPC for the short-term; managers and 
supervisors may be afraid to act on requests and applications 
until they get a clear impression of the new GMD's 
intentions, goals, likes and dislikes.  For his part, 
Kupolokun has publicly stated that he plans a comprehensive 
review of the organization, and will eliminate unnecessary 
positions and ineffective workers. 
 
 
 
 
17. (C) COMMENT: While it seems deregulation of the 
downstream sector has taken root, critical issues remain 
outstanding that might cause significant strain on the 
system. We will watch for continued complaints from unions 
and northerners regarding prices, and for attempts by 
government officials from the north to institutionalize 
temporary or holdover pricing schemes used to bridge the 
supply chain as in the past.  NNPC's Kupolokun will continue 
to press for reform, but a backlash is possible from those 
who benefited financially from the inefficiencies of the old 
system, and from managers within NNPC ranks he may try to 
sack along the way.  The link between currency exchange rates 
and the availability of dollars for the marketers to pay for 
their imports may have an impact on marketers' ordering 
decisions, and possibly on the valuation of the naira.  And 
implementation of the GON's announced intention to finally 
repair and privatize the country's refineries could affect 
both the volume and price of products and the relative 
strength of the players involved in the entire downstream 
sector. END COMMENT. 
 
 
GREGOIRE 
HINSON-JONES